Receivership: to trade or not to trade
29 April 2014
In this issue:
- The receiver’s decision to trade or close down a company’s business reviewed.
- The nature of receivership compared with other forms of insolvency administration.
- Commercial and legal factors that may impact on a receiver’s trade-on decision.
- Recent cases involving the receiver’s trade-on decision
Introduction
A receiver appointed by a secured creditor over the charged assets of a company that is trading will need to make a critical decision, namely, whether to continue to trade the company’s business, even for a limited duration, or whether to stem the trading losses by closing it down and disposing of the company’s charged assets.
The potential impact of this decision on the company is apparent, and in the event of business closure often leads to conflict with those persons associated with the company, usually on grounds that the decision to close the business was premature and too hastily arrived at.
For these reasons the complex mix of factors behind a receiver’s decision to trade or not to trade needs to be properly understood. This can be usefully achieved by firstly identifying the nature of receivership and the role of the receiver followed by a review of recent examples of the receiver’s trade-on decision.
Factors influencing a receiver’s trade-on decision
At the outset the nature and objectives of receivership, and the role of the receiver in light of those objectives need to be recognised. Comparing receivership with other forms of insolvency administrations is a useful way of achieving this. The following is an example of one court’s efforts in this regard:
“The function of a liquidator……is to preside over the death of a company. An administrator appointed in rescue proceedings strives for the opposite result (even though the company may in the end die). A receiver appointed by a secured creditor does neither of those things, being largely unconcerned about the fate of the company. From any perspective, the offices are poles apart."
Here the court recognises that the receiver’s principal obligation is not to rescue the company but to deal with the company’s charged assets in a manner best designed to meet the claims of the appointing secured creditor. In some cases that may entail trading the company’s business, in other cases it will not.
Notwithstanding the nature and objectives of receivership, there is a legal framework within which the receiver’s trade-on decision takes place.
Firstly, the powers of the receiver to carry on the business of the company or to dispose of the company’s property will have been the subject of agreement between the company and the secured creditor, and invariably will be set out in the charge document executed by the parties. Also section 420, Corporations Act is relevant in regards to the powers of receivers.
Next, as ASIC observes in its publication ‘Insolvency: A Guide For Shareholders,” although the receiver’s primary duty is to the company’s secured creditor, the receiver is under a statutory obligation (see section 420A, Corporations Act):
“…..to take reasonable care to sell charged property for not less than its market value, or if there is no market value, the best price reasonably obtainable. A receiver also has the same general duties as a company director.”
These legal obligations ensure that a receiver’s decision to trade or not to trade the company’s business will need to be well founded and reasonable. Moreover, under section 1321, Corporations Act a person aggrieved by a decision of a receiver has standing to appeal to the court in respect of the decision, and the court may confirm, reverse or modify the decision and give such directions to the receiver as it thinks fit.
Finally, the effect of section 419, Corporations Act needs to be recognised. That section renders the receiver personally liable for debts incurred in the course of the receivership. Although a receiver on taking up the appointment will usually have obtained a contractual indemnity from the appointor, the prospect of personal liability under this section, particularly where sufficiency of assets is uncertain, will have a significant influence on the receiver’s decision whether to avoid risk by closing down the company’s business.
Case studies involving the receiver’s trade-on decision
Insights into the receiver’s trade-on decision can be gained from reviewing recent cases concerned with this issue.
King v PFL Finance Limited (2012) NZCA 385, 28/8/2012.
This case from New Zealand involved a rural property owned by a family controlled company. The decision of the receiver to cease farming immediately on taking possession was vigorously opposed by the family involved. Although in these proceedings the merits of the competing arguments were not required to be fully explored by the Court of Appeal, it is informative to review the reasons put forward by the receiver justifying his decision not to trade the farm. They include:
- The farm had poor pastures with limited available feed of little nutritional value for feeding milking cows or fattening stock
- The fencing and gates were in a poor state of repair so as to ensure animals could be retained within the boundaries of the farm
- The property had no effective stock water
- The effluent system was compromised
- There was no proper identification of stock
- To bring the property to the value required to dispose of as a going concern the receiver would have to incur significant redevelopment and holding costs
- The monthly return from the farm after taking into account farm running costs was insufficient to justify trading the farm
In evaluating the above factors the receiver had obtained and relied on advice from a qualified source. Although the advice given was contested by the family controlled company, for the purposes of these proceedings the Court of Appeal concluded “there is no proper basis to prevent [the secured lender and the receiver] from exercising their powers…..”.
In the Matter of Harrisons Pharmacy Limited (Administrators appointed) (Receivers and Managers appointed) (2013) FCA 458, 21/5/2013.
In this case the receivers being in control of substantially all of the assets of the company made clear to the court their intention to trade the company’s businesses.
The receivers recognised that the “main assets of the businesses are goodwill and stock and if these assets are not sold as a going concern, sale prices would be substantially lower and unlikely to cover the amount of the secured creditor’s claimed debt….. “(para 23). To achieve this objective the receivers intended “to continue paying trade, lease and employee creditors during the receivership.” (para 27).
In response the court observed that as the businesses substantially comprised goodwill, stock and shop leases, the decision that “the businesses be sold as a going concern appears to be well founded and reasonable.” (para 41).
Note: The case involves a frequently encountered situation where the receiver seeks to trade the company’s business – at least for a limited period – in the hope of selling the business as a going concern. If successful this will usually achieve a higher price than would be recovered from breaking up the assets. It also gives the business a chance to survive under new management, including retention of staff, thereby avoiding significant redundancy payments to employees which would otherwise be paid ahead of the secured creditor’s debt. In the event that, within a reasonable time, satisfactory buyers are not forthcoming the receiver will commence the process of closing down the company’s business, disposing of the charged assets on a break up basis.
Concluding comments
We have seen that the receiver’s decision to trade, or not to trade, or to trade for a limited duration is a critical decision that needs to be made at an early stage of the receiver’s appointment. In some cases the receiver will have the benefit of pre-appointment insights into the company which will facilitate a quick response to this issue. In other cases the receiver will be unfamiliar with the company’s business necessitating an intense review of the company in order to form a view as to its trade-on potential.
The impact of the receiver’s decision on directors, shareholders, employees and trade creditors is apparent. For this reason the obligations of the receiver when dealing with a company’s assets are subject to significant legal controls.
Notwithstanding, the primary duty of the receiver is owed to the appointing secured creditor. Accordingly the legal framework within which this decision is made consistently acknowledges that the trade-on decision of the receiver, although needing to be justifiable and reasonable, will largely reflect the best interests of the appointing secured creditor.